By James Davis
As cryptocurrencies continue to witness mainstream adoption, several companies in the traditional finance (TradFi) sector are showing interest in digital assets. The entrance of TradFi firms in the crypto world has led to the emergence of crypto hedge funds. This article explores all aspects of crypto hedge funds and how they work.
What is a Crypto Hedge Fund?
A crypto hedge fund can be defined as a private club of investors who pool finances to accomplish their financial objectives. Crypto hedge funds operate in an environment with few regulations and are known to generate higher returns than traditional hedge funds.
Are There Crypto Hedge Funds?
The short answer to this question is yes! The increasing interest from investors to invest in crypto assets has given rise to several crypto hedge funds to meet the demand. Here are the five leading crypto hedge funds based on the value of assets under management (AUM).
1. Digital Currency Group: Assets managed are worth $50 billion.
2. Multicoin Capital: Manages assets worth $8.8 billion.
3. Polygon Capital: Assets managed are valued at $6.6 billion.
4. Amber Group: Assets under management are worth $5.1 billion.
5. Panter Capital: Manages assets worth $4.7 billion.
How a Crypto Hedge Fund Works
Most institutional investors don’t place trades on decentralized and centralized exchanges. Instead, they invest funds in cryptocurrencies through crypto hedge funds. Here is how these hedge funds work:
Portfolio Management
This aspect involves selecting the right crypto assets to invest in. The goal is to choose cryptocurrencies that can help investors gain profits. For example, Digital Currency Group’s portfolio has Bitcoin and various altcoins like Decentraland, Ethereum, and many more.
Capital Allocation
Capital allocation entails planning on the funds to invest in each crypto asset. Hedge funds need to be careful when allocating funds. They should not invest too much in highly volatile assets because it might affect the institution’s stability.
Alpha Generation
Crypto hedge funds usually aim to outperform the underlying assets. For example, suppose you inject money into a hedge fund that invests in Bitcoin and realize a 20% annual return while Bitcoin gives investors returns of less than 20%. In that case, your return will be regarded as positive alpha.
Risk Management
Cryptocurrencies are risky investments. However, crypto hedge funds employ several risk management strategies to ensure investors don’t lose their money. It could be through diversification, where a hedge fund invests in various assets so that when one asset is in a losing position, others may be winning, thus covering the losses.
Market Analysis
Crypto hedge funds don’t just invest in digital assets randomly. They first conduct a thorough market analysis, both technical and fundamental.
Types of Crypto Hedge Funds
Here are the various types of crypto hedge funds:
- Quantitative funds – They adopt mathematical, systematic, and algorithmic strategies.
- Long-only – These hedge funds only open long positions and never intend to short-sell.
- Short/long funds – Such hedge funds can switch from long-holding to short-selling depending on how the market is trending.
- VC funds – While most hedge funds invest in crypto assets, VC funds act as venture capitalists that inject money into crypto startups.
- Multi-strategy – Such crypto hedge funds apply multiple techniques to generate returns for their investors.
- Funds of Funds – These are hedge funds that look for well-performing hedge funds and then invest in them.
- Global macro – They are also known as Managed Futures funds. They usually trade future contracts.
Advantages and Disadvantages of Crypto Hedge Funds
Pros
- Crypto hedge funds allow Anyone across the world to invest.
- They give investors diversified exposure to crypto.
Cons
- Novice investors find crypto hedge funds complex to understand as they are still in the early stages.
- Regulatory uncertainty makes some investors reluctant to invest.
Conclusion
While the number of traditional hedge funds stepping into the crypto space has reduced in 2023, the value of assets under management has been on the rise since last year. Crypto hedge funds could witness massive adoption if clear regulations are implemented.